* ECB may buy Portugal, Ireland bonds in future
* Portuguese bonds outperform on the prospect
* But crisis still far from over in Portugal, euro zone
By Marius Zaharia
LONDON, Oct 26 The prospect of the European
Central Bank buying bonds of highly indebted euro zone countries
is accelerating Portugal's return to debt markets and
sustainable borrowing costs.
Since ECB President Mario Draghi pledged in late July to do
whatever it takes to save the euro, including curbing borrowing
costs, Portuguese bonds have outperformed all euro zone debt but
Yields, while still viewed as unsustainable, have dropped
below levels at which Spain has funded itself this year and are
seen falling further. At the start of 2012, Portuguese bond
prices signalled high expectations of a debt restructuring,
though these have now all but evaporated.
The crisis is not over in junk-rated Portugal, but bond
prices suggest the market thinks Lisbon has a good chance of
returning to markets when its 78-billion-euro bailout deal ends
"Portugal has been helped a lot by the fact that the ECB is
ready to buy bonds in the market," ING rate strategist
Alessandro Giansanti said. "Yes, there is a precondition that
they have to gain full market access ... but the probability
that they will come back next year is now more than 50 percent."
Full access, which analysts say would entail regular bond
sales, would allow the ECB to buy the debt via so-called
Outright Market Transactions (OMT). Successful sales may even be
enough to build a short-term momentum that carries yields to
levels where the ECB may not have to intervene.
But in the longer run, underlying worries about lack of
growth, high debt and a low credit rating are likely to make
investors nervous and ECB support may be needed, Giansanti said.
Portugal, which has been shut out of debt markets since its
bailout in May 2011, has already taken advantage of the Draghi
boost, swapping shorter-dated bonds for longer on Oct. 3.
It is following in the footsteps of bailed-out Ireland,
which analysts say is very close to issuing bonds regularly
after it held two successful bond swaps and sold long-term bonds
Both countries have gradually won back investor confidence
by sticking to the painful terms of their bailouts. But Portugal
still has much to do with its economy in recession, debts seen
at 118 percent of output and anti-austerity protests growing.
The International Monetary Fund warned on Thursday that
risks to Portugal's bailout plan have increased "markedly" due
to lower tax revenues.
All these risks are likely to prevent the significant
inflows of foreign capital, which Ireland is already seeing.
Zoeb Sachee, who heads European government bond trading for
Citi, a primary dealer of Portuguese debt, said domestic banks
have been the main buyers this year, while foreign demand came
from so-called fast money investors such as hedge funds.
Spain's bond markets have also been dominated by domestic
investors this year and that has supported demand at auctions.
However, this shift in ownership has raised concern over how
long local banks will be prepared to absorb the debt supply.
"If Portugal were to come back to the market, domestics
would need to step up," Sachee said, adding that high debts and
Portugal's "junk" credit rating were likely to keep longer-term
investors such as insurers or pension funds away.
"Foreign demand would still be speculative."
The yield on the benchmark 2021 bond fell to
7.5 percent this week, below a record high of 7.78 percent in
equivalent Spanish bonds hit in July. Two-year
bonds were last trading around 4.8 percent, way
below highs of over 7 percent for their Spanish counterpart.
Spain has retained access to debt markets, though this year
has largely restricted issuance to shorter-dated debt.
Ten-year Portuguese yields are a third lower than before
Draghi's pledge. Spanish and Italian yields have fallen by a
At the start of the year, yields above 19 percent priced in
a high probability that Portugal would follow Greece in
restructuring its debt. Now the probability is marginal.
Investors who bought Portuguese bonds at the start of 2012 would
pocket a profit of over 50 percent if they sold today,
according to Markit iBoxx indexes, a widely used benchmark.
ING's Giansanti estimates that if Portugal keeps on track
10-year yields could fall towards 6 percent, while two- and
five-year yields could drop below 4 percent in the next six
months -- levels he said were sustainable.
Morgan Stanley recommended investors buy long-dated bonds on
the view that they may be gradually re-gaining access to
markets, enabling ECB bond-buying. They did not publish price
targets for the trade.
Portugal could still be blown off course by a new flare-up
in the debt crisis and the ECB's bond-buying plan is yet to be
tested. But if it can return to markets, investors would see
that as a big step toward resolving the crisis.
"If you're coming out of a programme you are demonstrating:
1. a domestic success story and 2. that the policy response of
deficit adjustment and structural reform has worked," said UBS's
head of European interest rate strategy Justin Knight.
"That's a hugely optimistic message for the (euro) project."